The ECB’s financial stability report describes a 'fragile equilibrium' in world markets, with a host of underlying risks

By Ambrose Evans-Pritchard

8:36PM BST 28 May 2015

The ECB's financial stability report described a 'fragile equilibrium' in world marketsPhoto: Reuters

The global asset boom is an accident waiting to happen as the US prepares tighten monetary policy and the Greek crisis escalates, the European Central Bank has warned.

The ECB’s financial stability report described a “fragile equilibrium” in world markets, with a host of underlying risks and the looming threat of an “abrupt reversal” if anything goes wrong.

Europe's shadow banking nexus has grown by leaps and bounds since the Lehman crisis and has begun to generate a whole new set of dangers, many of them beyond the oversight of regulators.

While tougher rules have forced the banks to retrench, shadow banking has picked up the baton. Hedge funds have ballooned by 150pc since early 2008.

Investment funds have grown by 120pc to €9.4 trillion with a pervasive “liquidity mismatch”, investing in sticky assets across the globe while allowing clients to withdraw their money at short notice. This is a recipe for trouble in bouts of stress. “Large-scale outflows cannot be ruled out,” it said. The ECB warned that a rush for crowded exits could set off a wave of forced selling and quickly spin out of control. “Initial asset price adjustments would be amplified, triggering further redemptions and margin calls, thereby fueling such negative liquidity spirals,” it said.

Adding to the toxic mix, the shadow banks are taking on large amounts of “implicit leverage” through swaps and derivatives contracts that are hard to track. The issuance of high-risk “leveraged loans” reached €200bn last year, nearing the extremes seen just the before the Lehman crisis. Half of all issues this year had a debt/EBITDA ratio of five or higher, implying extreme leverage. The number of junk bonds sold reached a record pace of €60bn in the first quarter. “A deterioration in underwriting standards is evident in the increasing proportion of highly indebted issuers, below-average coverage ratios and growth in the covenant-lite segment,” the report said, warning that this nexus of debt is primed for trouble if there is an interest rate shock.

While banks are in better shape than five years ago, their rate of return on equity has dropped to 3pc, far lower than their cost of equity. They remain damaged. The immediate trigger for any market rout is the nerve-racking crisis in Greece, with just a week left until the Greek authorities must repay the International Monetary Fund €300m. Vitor Constancio, the ECB’s vice-president, said it is impossible to rule out a default since Greek officials themselves have openly threatened to do so, and this in turn could set off bond market contagion across southern Europe. The ECB’s report said the former crisis states still have extremely high levels of public and private debt and have yet to clean up government finances. “Fiscal positions remain precarious in some countries,” it said. “Financial market reactions to the developments in Greece have been muted to date, but in the absence of a quick agreement, the risk of an upward adjustment of the risk premia on vulnerable euro area sovereigns could materialise,” it said. The warnings echo cautionary words by the US Treasury Secretary, Jacob Lew, who said EU creditors were playing with fire if they thought a Greek ejection from the euro could be contained safely. “No one should have a false sense of confidence that they know what the risk of a crisis in Greece would be,” he told a forum in London. Yet the ECB said the bigger worry is what happens once the US Federal Reserve begins to raise interest rates, resetting the cost of long-term credit across the international system. It will be an ordeal by fire for those emerging markets with the highest dollar. The total exposure is $4.5 trillion.

Less likely, but equally worrying, is a “sudden slowdown” in the global economy that would bring Europe's unresolved debt problems back into focus. The report said aggregate debt levels are much higher than in 2008 at the onset of the last recession. A fresh relapse would change the trajectory of nominal GDP and play havoc with debt dynamics.

Simon Tilford, from the Centre for European Reform, said the latest cyclical recovery in the eurozone is too weak to undo the damage caused by the crisis and is unlikely to be enough to restore debt sustainability before the next recession hits. Nor has the currency bloc sorted out its essential deformities or embraced any form of fiscal union. “As it stands, the eurozone is a mechanism for divergence among its members, not convergence: real interest rates are highest in the weakest countries, lowest in the strongest,” he said. He warned that the region will probably go into the next downturn with rates still at zero – and therefore with no powder left – along with contractionary fiscal rules, and with unemployment already corrosively high. “Many eurozone governments could face the prospect of further deep recessions despite having barely recovered, amid persistently strong support for populist parties. The politics of this is likely to be combustible. The euro is not out of the woods,” he said.

Keynes never thought that an economy, felled by a shock, would remain on the floor. There would always be some rebound, regardless of government policy. What he emphasized was the “time-element” in the cycle. With depressed profit expectations, an economy could remain in a semi-slump for years. There would be alternating periods of recovery and collapse, but this oscillation would occur around an anemic average level of activity.

Neither the suddenness of the financial collapse of 2008-2009 nor the sluggishness of the recovery since then would have led Keynes to change his mind; nor has it discredited the claims of today’s Keynesians. While Ferguson includes several quotes from my past commentaries, he omits a very important passage: “All economies recover in the end. The question is how fast and how far.” The task of government was – and remains – to strengthen whatever “natural forces” of recovery exist, if necessary by providing businesses with a larger market, and, beyond this, to offset the inherent volatility of private investment through a stable program of public investment.

My argument with Ferguson concerns three main issues.

For starters, there is his view of the impact of austerity on Britain’s GDP. He cites the 2.6% growth in 2014 as a measure of austerity’s success. But this is nonsense. The real question is what austerity did to the economy over the five years of George Osborne’s tenure as Chancellor of the Exchequer. It is now widely agreed that, far from speeding up the recovery, Osborne’s austerity policy prolonged the slump:

Simon Wren-Lewis of Oxford University has pointed out that UK austerity was at its “most intense” in the first two years of Osborne’s chancellorship (2010-2011). The UK Office of Budget Responsibility, using conservative multipliers, calculated that austerity in this period reduced GDP growth by 1% in each year. That was the basis of Wren-Lewis’s calculation that austerity cost the average UK household the equivalent of at least £4,000. The economic recovery after 2012 coincided with the cessation of fiscal tightening.

Of course, coincidences are not causes. Keynesians cannot prove that the start of austerity aborted the recovery in 2010; that recovery would have come sooner if the pre-austerity level of public spending had been maintained; or that it was the reduction of austerity in 2012 that enabled the economy to expand again.

Nonetheless, the facts are consistent with Keynesian theory. Keynesians said austerity would cut output growth. Output growth fell. “[T]he Keynesians’ comparisons with the Great Depression [of 1929-1932] were plainly risible,” wrote Ferguson. In fact, real per capita GDP has taken longer to recover this time around. While it regained its 1929 level five years later, today, it is still below the 2008 level and looks as though it will take eight or nine years to regain it.

Keynesians also predicted that austerity would make it harder, not easier, for Osborne to hit his fiscal targets. Osborne said he would eliminate the structural deficit and have the debt/GDP ratio falling by 2015. Five years on, Osborne has failed to liquidate the deficit, no matter how you define it, and the debt/GDP ratio has risen from 69% to 80%.

Unlike Ferguson, Keynesians have a theory to explain why the targets were missed: If fiscal tightening makes the economy smaller than it would have been otherwise, it is much more costly to balance the books; and the attempt is likely to be abandoned or suspended for fear of social and political consequences. This is precisely what happened.

As a historian, Ferguson must know that it is growth, not austerity, that is most conducive to reducing the national debt as a share of GDP. Consider the following:

In 1929, the UK’s national debt was higher than it had been when World War I ended, despite (or because of) eight years of fiscal austerity. Conversely, from 1945 to 1970, the national debt shrank from 240% of GDP to 64% after 25 years of economic growth, most of it “real” (inflation-adjusted). Likewise, Paul Johnson, Director of the Institute for Fiscal Studies, said in December 2014 that it was not for lack of effort that the fiscal deficit had not fallen further. Rather, it was “because the economy performed so poorly in the first half of the parliament, hitting revenues very hard.”

The Keynesian argument, in sum, is that austerity hit the economy, and by hitting the economy, it worsened the fiscal balance. Does Ferguson accept this? If not, why not?

One of Ferguson’s key arguments is that austerity was necessary to restore confidence. Apparently, the bond markets did not agree. Long-term nominal and real interest rates were already very low before Osborne became chancellor, and they stayed low afterwards. The government could have taken advantage of this to borrow at negative real rates to invest, as all Keynesians advocated. It refused to do so.

In the Financial Times commentary to which I was responding, Ferguson wrote: “...at no point after May 2010 did [confidence] sink back to where it had been throughout the past two years of Gordon Brown’s catastrophic premiership” (my italics). But a graph that Ferguson himself posted gives the lie to this assertion:

.This shows confidence increasing from the low point of -45.3 in the first quarter of 2009 (the trough of the slump) to +25.8 in May 2010. It then went down, and did not regain its May 2010 level until the third quarter of 2013 – an interval of three years. In other words, contrary to Ferguson’s assertion, business confidence was higher in the last six months of Brown’s premiership than in the first two years of Osborne’s chancellorship.

A comparison with Figure 1 shows that confidence closely tracks the actual performance of the economy. Austerity did not pull confidence up; it pushed it down, because it pushed the economy down. It takes a particularly perverse form of rational expectations to argue that confidence will be increased by policies that cause the economy to stall.

In his Financial Times commentary, Ferguson cited the UK’s post-crash earnings and employment performance as proof that “austerity works.” “UK unemployment is now 5.6%, roughly half the rates in Italy and France,” he gushed. “Weekly earnings are up by more than 8%; in the private sector, the figure is above 10%. Inflation is below 2% and falling.”

Take earnings first. To show nominal earnings over five years side by side with inflation over one year is sleight of hand. After a correction from Jonathan Portes, Director of the UK’s Institute of Policy and Economic Research (and after first denouncing the correction as “contemptible”), Ferguson conceded in his Project Syndicate rejoinder that “from 2010 to 2015, average inflation-adjusted weekly earnings fell more than under any postwar government.”

Quite simply, with inflation rising faster than nominal wages, average real wages have fallen, and employment has grown, as standard theory would lead one to expect. The combination of tight fiscal policy and loose monetary policy failed, until 2013, to produce a recovery in output.

It did, however, lower the unemployment cost of reduced output – though not entirely: if the rise in involuntary part-time work is included in the cost, and as David Bell and David Blanchflower have done with their “underemployment index,” the UK government’s employment record is worse than Ferguson claims.

There was another cost to the relatively low unemployment of the recent recession, which Ferguson does not even mention: the collapse of productivity.

This is contrary to previous slump experience, when labor-shedding produced a rise in productivity.

The explanation is probably to be found in the way the labor market has adapted to government policy. A recent report by the UK’s Trade Union Congress (TUC) argues that austerity “has led directly to weaker economic growth, not only in the UK but across the world.”

In the UK, according to the TUC, “the reduction in growth has been met (almost) entirely by lower earnings growth rather than lower employment growth….Many new opportunities have been concentrated in low-pay occupations, and there has been an associated increase in underemployment, involuntary part-time work, poor quality self-employment and temporary work alongside greater insecurity through zero-hours contracts, agency work and other insecure or short- term contracts.”

Lower productivity “follows simply as an arithmetic consequence of this adjustment, with lower economic growth set against ongoing growth in the employment headcount.”

The austerity debate is of more than parochial British interest. Fiscal austerity remains the reigning orthodoxy in the eurozone. With soaring private-sector and household debt, the current global recovery looks very shaky, so it is important to attempt an accurate audit of the policy responses to the last collapse before the next one occurs.

Ferguson is right that everyone should learn from experience. Keynesians cannot expect to have it all their way. Demand-side policies should be coupled with supply-side measures to improve skills, infrastructure, and access to finance, and Keynesians have been slow to understand that a government cannot increase the national debt without limit for a cause in which most people do not believe.

But it seems to me that Ferguson is more interested in making political points than in developing properly grounded arguments. Until he tells us why he thinks that austerity was a good thing, his critics will be forgiven for seeing his economic pronouncements as nothing more than political propaganda.

Once in a while the question changes. Not so long ago western policy makers asked whether a rising China would sign up as a “responsible stakeholder” in the postwar global system. Now amid controversy over the Beijing-inspired Asian Infrastructure Investment Bank, they query whether a risen China’s plans to create a new international architecture can sit comfortably alongside the US-led order established in 1945.

Everyone in China is talking about President Xi Jinping’s “One Belt, One Road” initiative. No one seems to know precisely what it means. The experts and policy makers, who gathered this week in Guangzhou for the annual Stockholm China Forum hosted by the German Marshall Fund and Shanghai Institutes for International Studies, mulled half-a-dozen descriptions and interpretations.

For all that, everyone seems to understand that the push westwards is Mr Xi’s big play — a Eurasian grand strategy that will put beyond doubt China’s status as a global power.

All remaining trace of the diffidence that once marked China’s rise has disappeared. To suggest that China might have become overly assertive in its neighbourhood is to be guilty of “20th century thinking”. The 21st century mind, Beijing says, accepts Chinese power as a simple fact of geopolitics. As for stakeholding, well, great powers are not content with membership of other people’s clubs. They start their own.

Confusingly, the “road” part of Mr Xi’s project is not about retracing ancient silk roads, but expanding and securing maritime routes to the Middle East and Europe. Beijing has always seen the Strait of Malacca as a dangerous choke point. So it is reaching into the Indian Ocean.

The blueprint includes a deepwater naval base in Pakistan and another way to the sea through Myanmar and Bangladesh. Beijing is opening northern shipping routes to Europe as the ice melts in the Arctic. The navy, China’s latest military strategy paper says, has moved beyond the defence of offshore waters to “open-seas defence”.

As for the “belt”, the ambition extends beyond mere roads and railways — though officials are noticeably proud of a new rail freight route carrying Chinese manufactures from Zhengzhou overland through Russia to Hamburg. A $42bn aid package for Pakistan announced by Mr Xi is one piece in the mosaic of agreements and deals taking China westwards. The former Soviet Republics of Central Asia are to get power stations, manufacturing plants and pipelines in return for gas supply contracts.

A railway and highway will link China to the Arabian Sea. The new connections to the Horn of Africa and Europe will hasten the process of Eurasian economic integration.

There is a something-for-everybody quality about this. There were those at the Stockholm Forum who suspected that One Belt, One Road, was as much about presentation as grand strategy — a panoptic vision conjured up as the organising idea for a disparate set of objectives, motives and projects. Thus the aid for Islamabad is driven by the desire to limit support for Uighur separatists in Xinjiang province from Islamist extremists in Pakistan. The myriad infrastructure projects across the region are needed to soak up China’s excess industrial capacity. The move into the so-called “Stans” of central Asia is an opportunist response to Russian weakness following Vladimir Putin’s military adventurism in Ukraine; so too are the big gas deals with Moscow. And behind everything, of course, lies the existential imperative to secure supplies of natural resources and energy.Yet for all the ragged edges, put these initiatives together and they add up to a lot more than the sum of the parts. If great powers like to start their own clubs, they also set about turning economic weight into geopolitical clout. China insists the One Belt One Road enterprise has room for all, whether from the west or East Asia. It issued an open invitation to join the fledgling AIIB. Washington has since made itself look silly by trying, and failing, to organise a boycott of the new bank. The important thing, though, about all the initiatives is that China intends to set the parameters. As the London-based consultancy Trusted Sources puts it, Beijing is harnessing all its economic, financial and diplomatic muscle to drive a process of Eurasian integration from its own border to the Middle East, Africa and Europe. That adds up to quite a sphere of influence.It will not proceed smoothly, of course. Moscow is already uncomfortable in the role of junior partner in the Sino-Russian relationship. With good reason it is nervous about China’s move into the former Soviet Republics. Estrangement from the west has obliged Mr Putin to sell Russia cheaply. China’s old rival India is expanding its own naval presence in the Indian Ocean. Large cheques from Beijing will not smooth away the rivalries and competition for resources that bedevil central Asia. And the US could have told Beijing that pouring money into Islamabad does not buy security guarantees.China is not seeking to upend the existing global order. Not yet anyway. But the geostrategic message could scarcely be clearer. Beijing intends to be a rulemaker as much as a rule-taker. Even as it competes with the US in East Asia, it looks set on becoming pre-eminent in Eurasia. The west has to decide whether to become a stakeholder in someone else’s Project.

The IMF says we can no longer afford the economic wastage of fossil fuels, turning the green energy debate upside down as world leaders plan a binding climate deal in Paris

By Ambrose Evans-Pritchard

5:23PM BST 27 May 2015

The political noose is tightening on the global fossil fuel industry. It is a fair bet that world leaders will agree this year to impose a draconian “tax” on carbon emissions that entirely changes the financial calculus for coal, oil, and gas, and may ultimately devalue much of their asset base to zero.

The International Monetary Fund has let off the first thunder-clap. An astonishing report - blandly titled "How Large Are Global Energy Subsidies" - alleges that the fossil nexus enjoys hidden support worth 6.5pc of world GDP.

This will amount to $5.7 trillion in 2015, mostly due to environmental costs and damage to health, and mostly stemming from coal. The World Health Organisation - also on cue - has sharply revised up its estimates of early deaths from fine particulates and sulphur dioxide from coal plants.

The killer point is that this architecture of subsidy is a "drag on economic growth" as well as being a transfer from poor to rich. It pushes up tax rates and crowds out more productive investment. The world would be richer - and more dynamic - if the burning of fossils was priced properly.

This is a deeply-threatening line of attack for those accustomed to arguing that solar or wind are a prohibitive luxury, while coal, oil, and gas remain the only realistic way to power the world economy. The annual subsidy bill for renewables is just $77bn, trivial by comparison.

The British electricity group SSE (ex Scottish and Southern Energy) is already adapting to the new mood. It will close its Ferrybridge coal-powered plant next year, citing the emerging political consensus that coal "has a limited role in the future". The IMF bases its analysis on the work Arthur Pigou, the early 20th Century economist who advocated taxes to stop investors keeping all the profit while dumping the costs on the rest of society.

The Fund has set off a storm of protest. Subsidies are not quite the same as costs. Oil veterans retort that they have been paying 'social' taxes for a long time. But whether or not you agree with the IMF’s forensic accounting the publication of such claims by the world's premier financial body is itself a striking fact. The IMF is political to its fingertips. It rarely deviates far from the thinking of the US Treasury.

It is becoming clearer that last year's sweeping deal on climate change between the US and China was an historical inflexion point, the beginning of the end for a century of fossil dominance. At a single stroke it defused the 'North-South' conflict that has bedevilled climate policy and that caused the collapse of the Copenhagen talks in 2009. Todd Stern, the chief US climate negotiator, said the chemistry is radically different today as sherpas prepare for the COPS 21 summit in Paris this December. "The two 800-pound gorillas are working together," he said. Mr Stern claims that a constellation of states responsible for 60pc of global CO2 emissions are "already on board" for a binding deal, aimed at limiting the rise in carbon to 450 particles per million (ppm) and capping the rise in temperature to 2C degrees above pre-industrial levels by the end of the century. Climate scientists warn that we are currently on course for 4C degrees.

Potsdam Institute

Some countries have been startlingly bold. Mexico has vowed to cut gases by 40pc within fifteen years - and Black Carbon by 70pc - if there is a binding accord. Gabon has promised to cut emissions to 62pc below the current trend path within a decade. The hold-outs are a diminishing alliance, struggling to make a moral counter-argument. China has of course gone green with the zeal of the converted. "We are going to punish any violators who destroy the environment with an iron hand," said president Xi Jinping in March. Two coal-powered stations were shut down in Beijing that month. The last will be mothballed next year. Deutsche Bank expects China's coal use to peak as soon as 2016, an unthinkable prospect five years ago. The Communist Party knows its own survival is at stake. Anti-smog protests are spreading in the big cities, a political mass movement in waiting. "Under the Dome", a documentary on the country's toxic air and water, racked up over 100 million views on the internet within 24 hours two months ago. Beijing's censors suppressed it in panic.

Mr Xi promises to cap total CO2 emission by 2030, building 1000 gigawatts (GW) of solar, wind, and nuclear power in fifteen years. His country already has more wind power (115 GW) installed than Britain's entire energy system. It plans to add another 22 GW this year - equal to 15 nuclear reactors - building hundreds of miles of turbines across the North China steppe. The International Energy Agency says that two-thirds of all fossil fuel reserves booked by global companies can never be burned if the world reaches a 2C accord in Paris. The assets will be worthless.

The carbon pricing regime that must ineluctably follow any such accord - even if phased in gradually - would surely call into question a raft of deep-water drilling projects, and as well as the vast Kashagan filed in the Caspian where break-even costs have risen to $100 a barrel. The North Sea industry would go into run-off. A report by University College London said the Arctic would never be developed under a 2C degree policy. Over 75pc of Canada's oil would have to stay in the ground, as would 95pc of coal reserves in the US, Russia, and the Middle East, unless there are radical advances in carbon capture and storage.

The Bank of England has launched an enquiry to determine how much of the $5.5 trillion invested in fossil fuel exploration and development over the last six years is really viable, and whether it could become the new ‘subprime’ for the global financial system. This probe has now spread to the whole G20.

Carbon Tracker estimates that $1.1 trillion of investment has gone on ventures that will require oil prices above $95 a barrel over the next decade to break even. The big oil producers deny that they will be sitting on "stranded assets" under a 2C degree policy. Exxon insists that all its reserves will be needed - and much more besides - to meet rising global energy demand. Yet these companies cannot all be right. It is mathematically impossible. Jeremy Leggett, the chairman of Carbon Tracker, said Exxon is "placing a bet" that there will be no change in CO2 policy. "It asks its investors to be assured that there is zero risk – precisely zero risk," he said. A far-reaching climate deal would have been impossible a decade ago. There was little on the horizon to replace fossil fuel. This has suddenly changed. The advances in the cost and efficiency solar power are by now well-known. The US Solar Energy Industries Association (SEIA) says the average prices of photovoltaic modules dropped from $8 a watt in 2007 to $2.70 last year.

The new generation of cells cost around $0.80 a watt. First Solar is already producing modules for $0.40. Its commercial technology can capture 21.5pc of the sun's energy. In China, Wuxi Suntech Power claims the 'levelized' cost of electricity from solar modules will match the country's coal-powered stations as soon as next year.

A new report by the IEA says utility-scale solar is already operating at plants in Chile and Mexico, selling into the spot market without subsidies. Developers in the United Arab Emirates have signed contracts to deliver electricity from solar projects for as little as $59 per megawatt hour, matching the cheapest hydropower.

Less known is that the cost of battery storage is also falling fast. We are moving much closer to the day when it will be cheaper for those in low or mid latitudes to store energy when the sun is shining and release it later, than to draw power from the grid. The IEA estimates that the cost of a lithium-ion battery for grid-scale storage has fallen by more than three-quarters since 2008. The batteries last over three times as long.

Tesla's Elon Musk is jumping in with his usual bravado, vowing to liberate consumers from the grid and transform the "entire energy infrastructure of the world". His Powerwall rechargeable battery can clip on a garage wall and will retail for $3,000 to $3,500 (before installation costs), far lower than anything on the market. This is surely just the beginning. The world's scientific superpower is now throwing itself into the fight with gusto, conducting over 220 research projects into various forms of battery storage. Harvard University is working on an organic flow-battery - using quinones from rhubarb - that aims to cut costs by two thirds in three years and end reliance on rare earth minerals. With luck, we will overcome the curse of solar intermittency before the end of the decade. Mass production will follow by the mid-2020s. The switch to solar will by then be unstoppable. Fossils fuels are caught in a pincer squeeze, threatened with a 'Pigouvian' climate tax just at the moment when the upstart technologies are coming of age. Advocates of green energy must restrain their Schadenfreude. Coal drove the industrial revolution. Cheap energy from oil and gas has lifted billions of people out of poverty. Shell, BP, Exxon, Chevron, and their earlier incarnations, have done mankind a service, carrying out their work diligently in broad accord with the political consensus of an earlier time. The industry deserves a 'prosperity medal', and an honourable valediction

NEW YORK – The only surprise about the arrest of seven FIFA officials in a Swiss hotel in the early morning of May 27 is that it happened at all. Most people assumed that these pampered men in expensive suits, governing the world’s soccer federation, were beyond the reach of the law. Whatever rumors flew or reports were made on bribes, kickbacks, vote-rigging, and other dodgy practices, FIFA President Joseph “Sepp” Blatter and his colleagues and associates always seemed to emerge without a scratch.

So far, 14 men, including nine current or former FIFA executives (but not Blatter), have been charged with a range of fraud and corruption offenses in the United States, where prosecutors accuse them, among other things, of pocketing $150 million in bribes and kickbacks. And Swiss federal prosecutors are looking into shady deals behind the decisions to award the World Cup competitions in 2018 and 2022 to Russia and Qatar, respectively.

There is, of course, a long tradition of racketeering in professional sports. American mobsters have had a major interest in boxing, for example. Even the once gentlemanly game of cricket has been tainted by the infiltration of gambling networks and other crooked dealers. FIFA is just the richest, most powerful, most global milk cow of all.

Some have likened FIFA to the Mafia, and Blatter, born in a small Swiss village, has been called “Don Blatterone.” This is not entirely fair. So far as we know, no murder contracts have ever been issued from FIFA’s head office in Zürich. But the organization’s secrecy, its intimidation of the rivals to those who run it, and its reliance on favors, bribes, and called debts do show disturbing parallels to the world of organized crime.

One could, of course, choose to see FIFA as a dysfunctional organization, rather than a criminal enterprise. But even in this more charitable scenario, much of the malfeasance is a direct result of the federation’s total lack of transparency. The entire operation is run by a close-knit group of men (women play no part in this murky business), all of whom are beholden to the boss.

This did not start under Blatter. It was his predecessor, the sinister Brazilian João Havelange, who turned FIFA into a corrupt and vastly rich empire by incorporating more and more developing countries, whose votes for the bosses were bought with all manner of lucrative marketing and media deals.

Huge amounts of corporate money from Coca-Cola and Adidas went sloshing through the system, all the way to the roomy pockets of Third World potentates and, allegedly, of Havelange himself. Coke was the main sponsor of the 1978 World Cup in Argentina, ruled in those days by a brutal military junta.

Blatter is not quite as uncouth as Havelange. Unlike the Brazilian, he does not openly associate with mobsters. But his power, too, relies on the votes of countries outside Western Europe, and their loyalty, too, is secured by the promise of TV rights and commercial franchises. In the case of Qatar, this meant the right to stage the World Cup in an utterly unsuitable climate, in stadiums hastily built under terrible conditions by underpaid foreign workers with few rights.

Complaints from slightly more fastidious Europeans are often met with accusations of neo-colonialist attitudes or even racism. Indeed, this is what makes Blatter a typical man of our times. He is a ruthless operator who presents himself as the champion of the developing world, protecting the interests of Africans, Asians, Arabs, and South Americans against the arrogant West.

Things have changed since the days when venal men from poor countries were paid off to further Western political or commercial interests. This still occurs, of course. But the really big money now, more often than not, is made outside the West, in China, the Persian Gulf, and even Russia.

Western businessmen, architects, artists, university presidents, and museum directors – or anyone who needs large amounts of cash to fund their expensive projects – now have to deal with non-Western autocrats. So do democratically elected politicians, of course. And some – think of Tony Blair – turn it into a post-government career.

Pandering to authoritarian regimes and opaque business interests is not a wholesome enterprise. The contemporary alliance of Western interests – in the arts and higher education no less than in sports – with rich, undemocratic powers involves compromises that might easily damage established reputations.

One way to deflect the attention is to borrow the old anti-imperialist rhetoric of the left. Dealing with despots and shady tycoons is no longer venal, but noble. Selling the franchise of a university or a museum to a Gulf state, building yet another enormous stadium in China, or making a fortune out of soccer favors to Russia or Qatar is progressive, anti-racist, and a triumph of global fraternity and universal values.

This is the most irritating aspect of Blatter’s FIFA. The corruption, the vote-buying, the absurd thirst of soccer bosses for international prestige, the puffed-out chests festooned with medals and decorations – all of that is par for the course. It is the hypocrisy that rankles.

To lament the shift in global power and influence away from the heartlands of Europe and the US is useless. And we cannot accurately predict this shift’s political consequences. But if the sorry story of FIFA is any indication, we can be sure that, whatever forms government might take, money still rules.

Money printing by other nations, Japan, UK, Europe, etc, will support the dollar.

Both of the above support the US$ and put downward pressure on gold.

Background

Gold has 2 major hurdles to overcome and they are as follows:1. Interest rate rises in the US2. Money printing by other nations, Japan, UK, Europe, etc.Both support the US$ and put downward pressure on gold.

The specter of interest rate increases in the US hangs over the precious metals sector like the Sword of Damocles. The Federal Reserve has stated that they want to 'normalize' rates now that the period of Quantitative Easing is over. Employment figures published by the Department of Labour have shown a steady increase in the number of jobs created over the last twelve months or so. On the inflation front; core prices, which exclude food and energy, rose at a yearly pace of 1.8% for the month of April, which is the fastest monthly rise for almost a year. These data points will be viewed in a positive light by the Fed in that the economy is on track and recovering at a sufficient rate to allow for tighter monetary policy.The European Union has announced a program of Quantitative Easing for their members in an attempt to boost the European economy. The effect of this action will be to dilute the purchasing power of the euro and so its value will fall. The same goes for the British pound and the Japanese yen. These three currencies make up the lion's share of the US Dollar Index, so as they drop it follows that the dollar will rise. The rising dollar will exert downward pressure on gold rendering gold cheaper in dollar terms.

Conclusión

It should be mentioned that gold has been outperforming most currencies other than the US dollar to the benefit of those living or trading in such currencies. However, they have all underperformed when compared to the dollar, so for those who wish to hold some of their funds in cash then the dollar rules.At this stage of the cycle we remain of the opinion that the above mentioned factors weigh heavily on gold and as such gold's progress will be severely hampered in the coming months. We also believe that some investors will throw the towel in and walk away from this sector thus precipitating a final capitulation in the precious metals sector.The lion's share of our investment funds are in the dollar as it continues to outperform the precious metals sector and we think it will continue to do so for now.Patience is the order of the day and though it is not an exciting stance to take it certainly beats losing money.We will continue to watch the Fed for what they say and do bearing in mind that they are 'data driven' which tells us the situation is fluid and subject to change. However, for those who are waiting for the advent of more Quantitative Easing, this is not going to happen and is certainly not on the cards for this year.The producers may be cheaper than they have been for some time but that does not make them cheap or a viable investment opportunity. The mining sector has oscillated wildly this year but has gained nothing as the Gold Bugs Index, the HUI, is at the same level as it was in early January 2015.Rallies will come and go but without the formation of new higher highs and some decent traction, this sector is held prisoner by the rising dollar and the continuing dilution of the other major currencies.Patience is the order of the day and funds kept in US dollars are the current outperformers. Use this time to analyze and research the stocks that you would like to own and formulate a short list that you can manage and keep up with once you have made the purchase. Our watch list is huge but if we had to move tomorrow we have identified around 20 stocks that we would be happy to own and we will continue with the due diligence as a week can be a long time in the life of a mining company.We currently retain 70% of our funds in dollars and are glad we did so as they have strengthened considerably which should enable us to purchase more stocks and or gold and silver when the bargains present themselves.Stay flexible and don't be afraid to place the occasional short trade as and when the market is overbought. These trades may take time to eventuate, but as the outlook in the short term is bleak the risk/reward environment is favorable.Finally, go gently and only deploy small amounts of capital until a new direction is confirmed, we all need to be able to take a hit and live to fight another day.Got a comment, then please fire it in whether you agree with us or not, as the more diverse comments we get the more balance we will have in this debate and hopefully our trading decisions will be better informed and more profitable.Go gently.

Yields have defied predictions to rise; the 10-year German Bund still at odds with the economic Outlook

By Richard Barley

May 28, 2015 11:31 a.m. ETA U.S. flag flies on top of the Federal Reserve building in Washington, D.C. Photo: Bloomberg NewsApril’s bond market squall has subsided. Ten-year yields in the U.S., Germany and the U.K. are around 0.5 percentage point above their lows for the year. But by historical standards, including relative to other economic and financial indicators, they remain extraordinarily low.One rule of thumb for yields that has a decent historical track record is that they track nominal growth in gross domestic product. In the U.S., for instance, 10-year Treasury yields lagged behind nominal gross domestic product as inflation built in the 1970s, but then tracked lower as the U.S. Federal Reserve moved to rein in prices. Between 1980 and 2003, the two rates moved together relatively closely.Since then, the picture has become more confused. 10-year Treasury yields rose between 2003 and 2007, but not by as much as the pickup in nominal growth might have suggested; that was at the heart of former Fed Chairman Alan Greenspan’s bond conundrum. And since the start of 2010, U.S. nominal GDP growth has averaged 3.9%, while Treasury yields have averaged 2.5% based on quarterly data. Yields have persistently defied predictions that they would rise.

In the eurozone, the economy has taken a bigger hit, but even so, 10-year German Bund yields had departed from reality in April when they reached 0.05%; at 0.5% now they still are at odds with a brighter economic outlook for Europe. Yields are still negative for German bonds out to January 2020.Clearly, central bank policy since the global financial crisis, and in particular massive waves of quantitative easing, has pushed bond yields to levels lower than they otherwise would have been. But that seems unlikely to explain the disconnect fully. Bond yields appear to be painting a picture of permanently depressed growth and inflation; that seems hard to justify in the longer term.One suggestion is that the risk of new financial or economic trouble is hanging over investors and depressing bond yields. That might be being reinforced by the continuation of ultra-loose central bank policy, since some policy makers stress heightened uncertainty as a reason for keeping rates low.A move toward tighter monetary policy is the most likely catalyst for a further rise in long-dated bond yields. April already proved painful for bond investors. If the link between nominal growth and yields reasserts itself, there is plenty more pain to come.

America remains, despite the damage inflicted by the Great Recession and its aftermath, a very rich country. But many Americans are economically insecure, with little protection from life’s risks. They frequently experience financial hardship; many don’t expect to be able to retire, and if they do retire have little to live on besides Social Security.

Many readers will, I hope, find nothing surprising in what I just said. But all too many affluent Americans — and, in particular, members of our political elite — seem to have no sense of how the other half lives. Which is why a new study on the financial well-being of U.S. households, conducted by the Federal Reserve, should be required reading inside the Beltway.

Before I get to that study, a few words about the callous obliviousness so prevalent in our political life.

I am not, or not only, talking about right-wing contempt for the poor, although the dominance of compassionless conservatism is a sight to behold. According to the Pew Research Center, more than three-quarters of conservatives believe that the poor “have it easy” thanks to government benefits; only 1 in 7 believe that the poor “have hard lives.” And this attitude translates into policy. What we learn from the refusal of Republican-controlled states to expand Medicaid, even though the federal government would foot the bill, is that punishing the poor has become a goal in itself, one worth pursuing even if it hurts rather than helps state budgets.

But leave self-declared conservatives and their contempt for the poor on one side. What’s really striking is the disconnect between centrist conventional wisdom and the reality of life — and death — for much of the nation.

Take, as a prime example, positioning on Social Security. For decades, a declared willingness to cut Social Security benefits, especially by raising the retirement age, has been almost a required position — a badge of seriousness — for politicians and pundits who want to sound wise and responsible.

After all, people are living longer, so shouldn’t they work longer, too? And isn’t Social Security an old-fashioned system, out of touch with modern economic realities?

Meanwhile, the reality is that living longer in our ever-more-unequal society is very much a class thing: life expectancy at age 65 has risen a lot among the affluent, but hardly at all in the bottom half of the wage distribution, that is, among those who need Social Security most. And while the retirement system F.D.R. introduced may look old-fashioned to affluent professionals, it is quite literally a lifeline for many of our fellow citizens. A majority of Americans over 65 get more than half their income from Social Security, and more than a quarter are almost completely reliant on those monthly checks.

These realities may finally be penetrating political debate, to some extent. We seem to be hearing less these days about cutting Social Security, and we’re even seeing some attention paid to proposals for benefit increases given the erosion of private pensions. But my sense is that Washington still has no clue about the realities of life for those not yet elderly. Which is where that Federal Reserve study comes in.

This is the study’s second year, and the current edition actually portrays a nation in recovery: in 2014, unlike 2013, a substantial plurality of respondents said that they were better off than they had been five years ago. Yet it’s startling how little room for error there is in many American lives.

We learn, for example, that 3 in 10 nonelderly Americans said they had no retirement savings or pension, and that the same fraction reported going without some kind of medical care in the past year because they couldn’t afford it. Almost a quarter reported that they or a family member had experienced financial hardship in the past year.

And something that even startled me: 47 percent said that they would not have the resources to meet an unexpected expense of $400 — $400! They would have to sell something or borrow to meet that need, if they could meet it at all.

Of course, it could be much worse. Social Security is there, and we should be very glad that it is. Meanwhile, unemployment insurance and food stamps did a lot to cushion unlucky families from the worst during the Great Recession. And Obamacare, imperfect as it is, has immensely reduced insecurity, especially in states whose governments haven’t tried to sabotage the program.

But while things could be worse, they could also be better. There is no such thing as perfect security, but American families could easily have much more security than they have. All it would take is for politicians and pundits to stop talking blithely about the need to cut “entitlements” and start looking at the way their less-fortunate fellow citizens actually live.

Euro-sclerosis

By: Alasdair Macleod

Thursday, May 28, 2015

There appears to be little or nothing in the monetarists' handbook to enable them to assess the risk of a loss of confidence in the purchasing power of a paper currency. Furthermore, since today's macroeconomists have chosen to deny Say's Law¹, otherwise known as the laws of the markets, they have little hope of grasping the more subtle aspects of the role of money in price formation. It would appear that this potentially important issue is being ignored at a time when the Eurozone faces growing systemic risks that could ultimately challenge the euro's validity as money.The euro is primarily vulnerable because it has not existed for very long and its origin as money was simply decreed. It did not evolve out of marks, francs, lira or anything else; it just replaced the existing currencies of member states overnight by diktat. This contrasts with the dollar or sterling, whose origins were as gold substitutes and which evolved in steps over the last century to become standalone unbacked fiat. The reason this difference is important is summed up in the regression theorem.The theorem posits that money must have an origin in its value for a non-monetary purpose. That is why gold, which was originally ornamental and is still used as jewelry endures, while all government currencies throughout history have ultimately failed. It therefore follows that in the absence of this use-value, trust in money is fundamental to modern currencies.The theorem explains why we can automatically assume, for the purposes of transactions, that prices reflect the subjective values of the goods and services that we buy. This is in contrast with money that is not consumed but merely changes hands, and both parties in a transaction ascribe to money an objective value. And this is why the symptoms of monetary inflation are commonly referred to as rising prices instead of a fall in the purchasing power of money.The European Central Bank (ECB) is plainly assuming the euro is money on a par with any other major currency with a longer history. Despite caution occasionally expressed by sound-money advocates in Germany's Bundesbank, the ECB is aggressively pursuing monetary policies designed to weaken its currency. For example, it has reduced its deposit rate for Eurozone banks to minus 0.2%. This is wholly unnatural in a world where possession of money is always more valuable than an IOU. Furthermore banks are encouraged to limit their customers' cash withdrawals, often under the guise of fighting tax evasion or money laundering. But in Greece restrictions on cash withdrawals are clearly designed to protect the banks.So far, there is nothing identified in this article that actually points to a destabilisation of the euro, other than it's generally a bad idea to fool around with peoples' rights to it. But lets assume for a moment that Greece defaults. In that case the Greek banking system would certainly collapse (assuming the ECB suspends its emergency liquidity assistance (ELA) because bad debts already on their balance sheets exceed tangible equity by a substantial margin. If that assistance is withdrawn, some €80bn of ELA will be lost. Furthermore, TARGET2² settlement imbalances at the other Eurozone central banks, which have arisen through capital flight from Greece and which are guaranteed by the ECB, total a further €42bn. This leaves the ECB in the hole for €122bn. Unfortunately, the ECB's equity capital plus reserves total only €96bn, so a Greek default would expose the euro's issuing bank to be woefully under-capitalised.Therefore, if Greece defaults we would at least expect the validity of this relatively new euro to be challenged in the foreign exchange markets. Even if the ECB decided to rescue what it could from a Greek default by rearranging the order of bank creditors in its favour through a bail-in, it would still have to make substantial provisions from its own inadequate capital base. For this reason, rather than risk exposing the ECB as undercapitalised, it seems likely that Greece will be permitted to win its game of chicken against the Eurozone, forcing the other Eurozone states to come up with enough money to pay off maturing debt and cover public sector wages. So will that save the euro?Perhaps it will, but if so maybe not for long. If the Eurozone's finance ministers give in to Greece, it will be harder for other profligate nations to impose continuing austerity. Anti-austerity parties, such as Podemas in Spain, are increasingly likely to form tomorrow's governments, and Spain faces a general election later this year. Prime Minister Renzi and President Hollande in Italy and France respectively are keen to do away with austerity and increase government spending as their route to economic salvation. Unfortunately for both the undercapitalised ECB and its young currency, they are increasingly likely to be caught in the crossfire between the Northern creditors and the profligate borrowers in the South.Even if Greece is to be saved from default, the ECB will need to strengthen the Greek banks. This is likely to be done in two ways: firstly by forcing them to recapitalise with or without bail-ins, and secondly to restrict money outflows through capital controls and harsh limits on depositor withdrawals if need be. Essentially it is back to the Cyprus solution.Whichever way Greece is played, Eurozone residents will see themselves having a currency that is becoming increasingly questionable. The bail-in debacle that was Cyprus is still etched in depositors' minds. Cyprus certainly has not been forgotten in Greece, where ordinary people are now resorting to buying mobile capital goods that can be easily sold, such as German automobiles, with the bank balances that cannot be withdrawn in cash and are otherwise at risk from a Cyprus-style bail-in. Greek depositors have realised that euro balances held in the banks are not reliably money. Folding cash is still money, but that is all, and furthermore the folding stuff is rationed.The next blow for the euro could come from the exchange rate. If the euro continues to lose purchasing power on the foreign exchanges, it is likely to undermine confidence on the ground. And when that happens it will be increasingly difficult for the ECB to retrieve the situation and maintain the euro's credibility as money. It just doesn't seem sensible to take such enormous risks with a currency that has existed for only thirteen years.

¹'Say's Law Of Markets' An economic rule that says that production is the source of demand. According to Say's Law, when an individual produces a product or service, he or she gets paid for that work, and is then able to use that pay to demand other goods and services.

²TARGET2 is an interbank payment system for the real-time processing of cross-border transfers throughout the European Union. TARGET2 replaced TARGET (Trans-European Automated Real-time Gross Settlement Express Transfer System) in November 2007.

If you know the other and know yourself, you need not fear the result of a hundred battles.

Sun Tzu

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.